CION Investment Corporation (CION) Q4 2022 Earnings Call Transcript

CION Investment Corporation (NYSE:CION) Q4 2022 Results Conference Call March 16, 2023 11:00 AM ET

Company Participants

Michael Reisner - Co-Chief Executive Officer

Gregg Bresner - President and Chief Investment Officer

Keith Franz - Chief Financial Officer

Conference Call Participants

Finian O'Shea - Wells Fargo

Operator

Thank you. Good morning, and welcome to the CION Investment Corporation's Fourth Quarter and Year Ended December 31, 2022, Earnings Conference Call. An earnings press release was distributed earlier this morning before market opened. A copy of the release, along with the supplemental earnings presentation, is available on the company's website at www.cionbdc.com in the Investor Relations section and should be reviewed in conjunction with the company's Form 10-K filed with the SEC.

As a reminder, this conference call is being recorded for replay purposes. Please note that today's conference call may contain forward-looking statements, which are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described in the company's filings with the SEC.

Speaking on today's call will be Michael Reisner, CION Investment Corporation's Co-Chief Executive Officer; Gregg Bresner, President and Chief Investment Officer; and Keith Franz, Chief Financial Officer.

And with that, I would now like to turn the call over to Michael Reisner. Thank you. Please go ahead, Michael.

Michael Reisner

Thank you, John. Good morning, everyone, and thank you for joining us today. As mentioned, I'm joined today by Gregg and Keith as well as other members of senior management, including my Co-CEO, Mark Gatto. I will start our call today with an overview of our fourth quarter and full year results. Gregg will then review our investment activity during the quarter, and Keith will provide additional detail on our financial results. After Keith's prepared remarks, we will open the call for questions.

As we reported this morning, we had another solid quarter and year, which reflects, we believe, not only higher rates, but our stable credit performance and our focus on first lien loans to middle market companies. We continue to provide our shareholders with strong returns on their investment. As has been the case each quarter for the past year, our fourth quarter net investment income of $0.43 per share outearned the $0.31 per share dividend we declared for the fourth quarter of 2022.

Accordingly, given our continued strong performance, we are declaring today an almost 10% increase in our dividend to $0.34 per share. This comes on the heels of the special dividend of $0.27 per share we declared at the end of the fourth quarter 2022.

2022 marked our first full year as a traded entity and our 10th as a public BDC, and we are proud of what we have been able to accomplish. As we have previously communicated, we operated and structured our strategy to build a defensive portfolio to withstand a turbulent and challenging macroeconomic environment. Our performance, similar to the performance of many of our peers, was affected by macroeconomic factors, including increases in credit spreads, downward mark-to-market pressures and overall volatility.

Our strategy on how to overcome these challenges remains cautionary and defensive while we remain predominantly first lien, highly diversified floating rate lender, refraining from unnecessarily reaching for yield by going down the capital stack. We believe that this strategy helped not only to drive our solid portfolio performance, but also positions us well to confront any additional challenging economic headwinds that we may face during 2023.

I'm proud to say that we ended the year with a strong portfolio and solid credit metrics in the face of this challenging market environment. While we are pleased with our performance, we are cognizant of the uncertain times and potential challenges ahead. While higher interest rates continue to challenge some companies, most of our portfolio companies are conservatively levered and, we believe, capable of withstanding the stress. Further, in instances where there may be some stress, being a first lien lender to less aggressively levered middle market companies provide significant comfort.

Although during the year, we saw a slight increase in non-accruals, those accounted for just 1.3% and 2% of the overall portfolio as fair value and amortized costs, respectively. The weighted average leverage or net debt to EBITDA of our portfolio companies increased to 5.3 times as compared to 5.11 times on September 30. The weighted average interest coverage of our portfolio companies decreased to 2.31 times as compared to 2.66 times in the third quarter of 2022.

While we continue to be opportunistic and implement a measured investment strategy, we do have an extremely robust pipeline. This, coupled with the fact that we are modestly levered as compared to our peers, gives us the confidence that we will be able to continue to grow our portfolio, remain measured in a healthy way. We believe to be highly opportunistic in this market, liquidity management is paramount.

Just last month, we announced the closing of approximately $81 million in aggregate principal amount of Series A unsecured notes due in 2026 to a public offering in Israel, which was 1.3 times oversubscribed. The notes bear interest at a rate equal to the Secured Overnight Financing Rate plus a credit spread of 3.82% per year. In conjunction with this offering, we also announced the listing of these notes and the dual listing of our common shares on the Tel Aviv Stock Exchange.

This offering has further strengthened our balance sheet through an unsecured and floating rate structure that provides interest rate risk mitigation and the potential for increased returns while at the same time further diversifying our financing sources. We will be using the net proceeds from this offering to capitalize on new investment opportunities as we seek to provide our shareholders with accretive returns over the long term.

We also continued our share repurchase program this quarter, repurchasing 963,480 shares at an average price of $9.06 for a total repurchase amount of $8.7 million. We have repurchased shares totaling 1.7 million for a total repurchase amount of $15.4 million since the beginning of the repurchase program in August 2022.

We have entered 2023 well positioned to take advantage of sound investment opportunities arising from this environment without deviating from our core investment strategy. And we believe our portfolio is structured in such a way as to provide -- to prove resilient in uncertain times.

Before I turn it over to Gregg for an overview of our investment activity for the quarter and the year, I want to address the issues of last week involving the banking industry and how it pertains to our portfolio and our portfolio companies.

While we continue to monitor the evolving situation, as of today, only one of our portfolio companies had any direct exposure to Silicon Valley Bank or Signature Bank, and that company has received all of its deposits. Our overall exposure to regional banks is limited, as is our exposure to the technology industry in general, which account for less than 3.2% at year-end.

The likely fallout, which may increase uncertainty in the overall economy, could lead to a reduction of lending by banks as smaller banks are likely to face increased regulation. In addition, banks may limit their lending in the short term to preserve liquidity, thus increasing the opportunity for us and other direct lenders.

I will now turn the call over to Gregg.

Gregg Bresner

Thank you, Michael, and good morning, everyone.

During 2022, we operated in the challenging market conditions we foreshadowed for our investors during our Q3 2021 earnings call. The disproportionately high level inflows into loan funds and the resulting excess market liquidity masked the deteriorating credit fundamentals in 2021. In 2022, the market had to confront the realities of high inflation, substantial interest rate hikes and operating challenges from supply chain and labor market constraints as fundraising pulpit.

As we discussed during our Q4 2021 earnings call, we were already defensively positioning our investment portfolio for this expected reality for our continued highly diversified first lien investment focus on floating rate assets. This strategy served us well as we achieved a nearly 19% increase in net investment income for full year 2022.

In the fourth quarter, our net investment income benefited from the direct pass-through of higher interest rates from our primarily floating rate first lien assets as well as dividends, fees, prepayment premiums and other yield-enhancing provisions within our portfolio. We expect that trend to continue in the first quarter of 2023.

Our total return to investors for full year 2022 was 10.44%, which included the impact of mark-to-market declines due to increasing spreads and volatility in the overall markets. Our full year 2022 total return to shareholders of 10.44% compares favorably to the 0.6% loss for the S&P/Morningstar Leveraged Loan Index and the nearly 20% loss in the S&P Equity 500 Index for the same period.

Our defensive strategic positioning also contributed to our ability to declare a nearly 10% increase to our base quarterly dividend to our shareholders for the first quarter of 2023. We continue to believe that liquidity and net leverage to capitalization metrics represent the most important focus points for our portfolio as well as the broader market.

The pivot over the last several years to covenant life financings and looser credit documents in the syndicated and larger cap loan markets has diluted the predictive value and importance of historical default rate data. In addition to being an inherently lagging indicator, it is also difficult to compare historical default data with the loan vintages in the syndicated loan market that contain little to no maintenance financial covenants.

We continue to emphasize our liquidity focus as there is no doubt that increasing interest rates, higher inflation and supply chain challenges have heightened the working capital needs of most middle-market companies. Even those companies operating with the least direct impact from the current market headwinds and COVID-related challenges have needed additional working capital just to sustain their operations.

There continues to remain a clear distinction between the syndicated and the direct private credit markets where we strategically focus. As syndicated market conditions continued to deteriorate in 2022 with declining new issue activity, higher volatility and spread widening, private direct lending continued to expand its market share with robust issuance and yield opportunities.

Turning now to our Q4 portfolio and investment activity. We ended the year with strong liquidity and a conservative net debt-to-equity profile of approximately 1 times. We continue to be highly opportunistic with respect to new first lien investment opportunities in both the directly sourced and lightly syndicated loan markets. Our focus in the first lien syndicated loan markets has largely been opportunities with valuation distress due to technical or capital structure-related situations where we expect to have active roles in the processes that drive the refinancing or restructuring of the investment tranches.

During Q4, we made $92 million in new investment commitments, which included three new portfolio companies seeking to grow through strategic acquisitions. Of the $92 million in new investment commitments made during the quarter, $83 million was funded. We also funded a total of $16 million of previously unfunded commitments.

While our new investment activity was relatively strong in Q4, we maintained a prudent approach in preserving capital for investment in the strong pipeline and challenging economic environment we see ahead. Our successful unsecured note issuance in Israel in Q1 provided incremental capital to pursue such opportunities.

Notwithstanding the macro challenges in the market, we continue to have a relatively robust sales and repayments totaling $144 million for the quarter. This was primarily driven by the full repayment of five investments and the selective sale of four lower-yielding names. As a result, net funded investment activity decreased by $46 million during the quarter, and the number of portfolio companies decreased from 119 at the end of Q3 to 113 at the end of Q4.

At year-end, the total fair value of our portfolio was about $1.75 billion. The investment portfolio was comprised of 92.5% senior secured loans, including 90.3% in first lien investments. Approximately 89.8% of the performing loan portfolio was in floating rate investments.

As of December 31, the yield on our performing loan portfolio increased to a gross annual yield before leverage of 12.61%, up materially from 10.98% at the end of the third quarter of 2022 and 9.16% at the end of 2021, with a weighted average purchase price of 97.81% of par at an average investment size of about $15 million per portfolio company as of 12/31/22.

As with our market peers, we have experienced some movements in our overall portfolio credit metrics. As of December 31, investments on non-accrual status increased slightly to 1.3% and 2% of the total investment portfolio at fair value and at amortized costs, respectively, as we added three new investments to non-accrual status. This compares to 0.4% and 1.7%, respectively, at the end of the third quarter of 2022. The three investments we added to nonaccrual status are tranches from NBG, Jenny Craig and David Spraddle.

With respect to our internal risk ratings, we did experience a slight uptick in the total amount of our risk-weighted 4 and 5 names from 0.4% at the end of Q3 to 2.2% of our total portfolio at the end of Q4.

We are not immune to the challenging market conditions and expect to continue to work through investments where restructurings or incremental investments may be needed. We are first lien investors in 4 companies that have sought bankruptcy protection for financial and/or strategic reasons: Vesta, Heritage Power, NBG and IPP. We have an intent to remain actively involved in these situations and utilize our first lien position, investment flexibility and rights to help optimize the successful emergence and eventual realizations of these investments.

I will now turn the call over to Keith.

Keith Franz

Okay. Thank you, Gregg, and good morning, everyone. As Michael mentioned, we reported another quarter of solid financial results, driven by an increase in LIBOR and SOFR rates and dividends earned on our investments. These increases were offset by lower fees generated from our quarterly investment activity.

During the quarter, net investment income was $23.9 million or $0.43 per share as compared to $25.6 million or $0.45 per share reported in the third quarter. For the full year, net investment income was $88.2 million or $1.56 per share compared to $74.3 million or $1.31 per share for the full year 2021. This is an increase of $0.25 per share or about 19% year-over-year.

Total investment income was slightly higher during the quarter to $55.5 million compared to $54.2 million reported during the third quarter. Total investment income for the full year was $194.9 million compared to $157.3 million for all of 2021, which is an increase of $37.6 million or about 24% when compared to the prior year.

On the expense side, total operating expenses increased to $31.6 million compared to $28.6 million in the third quarter. The increase was primarily driven by an increase in interest expense under our financing arrangements due to higher LIBOR and SOFR rates when compared to the prior quarter.

At December 31, we had total assets of approximately $1.9 billion and total net assets of $884 million with total debt outstanding of $958 million with 55.3 million shares outstanding. As a result, at the end of the quarter, our debt-to-equity ratio was 1.08 times, which is slightly higher when our debt -- when compared to our debt-to-equity ratio of 1.05 times in Q3.

Total debt outstanding increased by $128 million since year-end 2021, which reflects the measured growth of our portfolio using additional debt capital.

At December 31, our NAV was $15.98 per share as compared to $16.26 per share at September 30. The decrease of $0.28 per share was primarily due to the special year-end distribution of $0.27 per share that was declared at the end of December and price declines in our portfolio. This was partially offset by the accretive nature of our share buyback plan during the quarter.

We ended the year with a strong and flexible balance sheet with almost $500 million in unencumbered assets, low leverage, a strong debt servicing capacity and solid liquidity. We had over $94 million in cash and short-term investments and access to an additional $72 million under our credit facilities to further finance our investment pipeline and continue to support our existing portfolio companies.

Our current debt mix is 79% in senior secured and 21% in unsecured. After closing on the unsecured bond deal in February 2023, the unsecured percentage of our debt mix moves up to about 30% of our total debt capital. During the quarter, the weighted average cost of our debt capital was about 6.7%.

We should continue to see the positive impact to net investment income as we continue to deploy our available capital into new middle-market floating rate investments that typically pay a yield premium when compared to large, broadly syndicated deals.

As interest rates continue to rise, we expect an increase to our net interest income of about $0.12 per share for the next 100 basis point increase to the base rate as of December 31 and $0.25 for a 200-basis point increase to the base rate, and that's assuming no material changes to the investment portfolio or a debt structure.

Turning to distributions. During the fourth quarter, we declared distributions to our shareholders of $0.58 per share, which consisted of a base quarterly distribution of $0.31 per share and a special year-end distribution of $0.27 per share. For the full year, we declared total distributions of $1.45 per share, which is an increase of $0.19 or about 24% over the total distributions declared during 2021.

As announced this morning, we declared our first quarter distribution of $0.34 per share, which is an increase of $0.03 per share or an increase of about 10% over the fourth quarter distribution. This distribution will be paid on March 31 to shareholders of record on March 24. This is now the third time we have increased our quarterly distribution since we listed back in October 2021.

Okay. With that, I will turn the call back over to Michael for some closing remarks.

Michael Reisner

Thanks, Keith. I think with that, John, we're ready to take any questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Finian O'Shea with Wells Fargo. Please proceed with your question.

Finian O'Shea

Hi, everyone. Good morning. Keith, on the liability side, you have the UBS maturing later this year and the JPM facility that revolving period ends in May. Any color you can give us on the progress in replacing those, if the sort of facilities might change in nature and potentially terms if we're looking at wider spreads here? I appreciate any color you can give us.

Keith Franz

Fin, yes, so we currently work on that. We're currently in conversations addressing those two facilities. So, a little too early to tell at this point. But I think there's no indications of widening credit spreads at this point. So, it's really -- we'll see as we progress through this.

Finian O'Shea

Okay. That's helpful. Thank you. And then just a higher level of portfolio question. Appreciating your portfolio companies have a bit lower leverage in the core middle market. Are you able to provide the current looking forward with today's earnings and today's yield, spot LIBOR, the current portfolio interest coverage?

Keith Franz

Well, we provided the -- in the...

Michael Reisner

On a pro forma a go-forward basis then?

Finian O'Shea

Yes. Well, using the current sort of spot rate on LIBOR, I know the curve probably points down a little bit. But from where we are here in current earnings, as I know a lot of the covenant packages, for example, are based on trailing 12 months, and those are the numbers we often get. So yes, just kind of that today sort of as is, what your, let's say, what your borrowers are paying or how much their coverage is in 1Q '23?

Gregg Bresner

It's consistent with what we were reporting today and, in our K., We don't see any significant deviation from that.

Finian O'Shea

Okay, great. Thank you, so much.

Operator

[Operator Instructions] And this concludes our question-and-answer session. I would now like to turn the call back over to management for any final comments.

Michael Reisner

Thank you, everyone, who joined the call today. We do appreciate your interest in CION, and we look forward to speaking to you again in early May when we announce our first quarter 2023 results. Take care, everyone.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.